The pace of Wall Street’s war against the 99% is quickening in preparation for the kill. Having demonized public employees for being scheduled to receive pensions on their lifetime employment service, bondholders are insisting on getting the money instead. It is the same austerity philosophy that has been forced on Greece and Spain – and the same that is prompting President Obama and Mitt Romney to urge scaling back Social Security and Medicare.

Unlike the U.S. federal government, most states and cities have constitutions that prevent them from running budget deficits. This means that when they cut property taxes, they either must borrow from the wealthy, or cut back employment and public services.

For many years they borrowed, paying tax-exempt interest to wealthy bondholders. But carrying charges on these have mounted to a point where they now look risky as the economy sinks into debt deflation. Cities are defaulting from California to Alabama. They cannot reverse course and restore taxes on property owners without causing more mortgage defaults and abandonments. Something has to give – so cities are scaling back public spending, downsizing their school systems and police forces, and selling off their assets to pay bondholders.

This has become the main cause of America’s rising unemployment, helping drive down consumer demand in a Keynesian nightmare. Less obvious are the devastating cuts occurring in health care, job training and other services, while tuition rates for public colleges and “participation fees” at high schools are soaring. School systems are crumbling like our roads as teachers are jettisoned on a scale not seen since the Great Depression.

Yet Wall Street strategists view this state and local budget squeeze as a godsend. As Rahm Emanuel has put matters, a crisis is too good an opportunity to waste – and the fiscal crisis gives creditors financial leverage to push through anti-labor policies and privatization grabs. The ground is being prepared for a neoliberal “cure”: cutting back pensions and health care, defaulting on pension promises to labor, and selling off the public sector, letting the new proprietors to put up tollbooths on everything from roads to schools. The new term of the moment is “rent extraction.”

So having caused the fiscal crisis, the legacy of decades of property tax cuts financed by going deeper into debt are now to be paid for by leasing or selling off public assets. Chicago has leased its Skyway for 99 years to toll-collectors, and its parking meters for 75 years. Mayor Emanuel has hired J.P.Morgan Asset Management to give “advice” on how to sell privatizers the right to charge user fees for previously free or subsidized public services. It is the modern American equivalent of England’s Enclosure Movements of the 16th to 18th century.

By depicting local employees as public enemy #1, the urban crisis is helping put the class war back in business. The financial sector argues that paying pensions (or even a living wage) absorbs tax revenue that otherwise can be used to pay bondholders. Scranton, Pennsylvania has reduced public-sector wages to the legal minimum “temporarily,” while other cities are seeking to break pension plans and deferred-wage contracts – and going to the Wall Street casino and play losing games in a desperate attempt to cover their unfunded pension liabilities. These recently were estimated to total $3 trillion, plus another $1 trillion in unfunded health care benefits.

Although it is Wall Street that engineered the bubble economy whose bursting has triggered the urban fiscal crisis, its lobbyists and their Junk Economic theories are not being held accountable. Rather than blaming the tax cutters who gave bankers and real estate moguls a windfall, it is teachers and other public employees who are being told to give back their deferred wages, which is what pensions are. No such clawbacks are in store for financial predators.

Instead, foreclosure time has arrived to provide a new grab bag as cities are forced to do what New York City did to avert bankruptcy in 1974: turn over management to Wall Street nominees. As in Greece and Italy, elected politicians are to be replaced by “technocrats” appointed to do what Margaret Thatcher and Tony Blair did to England: sell off what remains of the public sector and turn every social program into a profit center.

The plan is to achieve three main goals. First, give privatizers the right to turn public infrastructure into tollbooth opportunities. The idea is to force cities to balance budgets by leasing or selling off their roads and bus systems, schools and prisons, real estate and other natural monopolies. In the process, this promises to create a new market for banks: lending to vulture investors to buy rights to install tollbooths on the economy’s basic infrastructure.

Elected public officials could not engage in such predatory and anti-labor policies. Only the “magic of the marketplace” can break public labor unions, downsize public services and put tollbooths on the roads, water and sewer systems while cutting back bus lines and raising fares.

To achieve this financial plan, it is necessary is to frame the problem in a way that rules out less anti-social alternatives. As Margaret Thatcher put matters, TINA: There Is No Alternative to selling off public transportation, real estate, and even school systems and jails.

Dismantling public education and police departments to pay bondholders

Local tax policy used to be about education. The United States was divided into fiscal grids to finance school districts, along with roads and bus lines, water and sewer systems. Municipalities with better schools taxed their property more, but this made it more desirable to live in such districts, and thus raised rather than lowered real estate prices. This made urban improvement self-feeding. Lower-taxed districts were left behind.

This no longer is the American way. Education in particular has been demonized. California’s formerly great school system is the most visible casualty of the state’s Proposition 13, the property tax freeze enacted in 1978. The Los Angeles Apartment Owners Association employed its political front man, Howard Jarvis, as a lobbyist to promise voters that little would change by cutting back education and libraries. He claimed that “63 percent of the graduates are illiterate, anyway,” so who needed books. Education and other parts of public spending was frozen as property taxes were slashed by 57% – from 2.5 or 3% down to just 1% of assessed valuation, and were frozen at 1978 price levels for owners who have kept their property. The result is that California’s school system has plunged to 47th rank in the nation.

For neoliberals, the silver lining is that downgrading education makes citizens more susceptible to the Tea Party’s false consciousness when it comes to how to vote in their economic interest. Back when Prop. 13 was passed, for instance, commercial investors promised homeowners that across-the-board tax cuts would make housing more affordable and that rents would fall. But they rose, along with real estate prices. This is the Big Lie of neoliberal tax cutters: the promise that cutting tax will lower costs rather than provide a windfall for property owners – and also for banks as rising rental values are “free” to be capitalized into larger mortgage loans. New buyers need to pay more, raising the cost of living and doing business.

Back in 1978 on the eve of Proposition 13 commercial owners paid half the real estate taxes and homeowners the other half. But now the homeowners’ share has risen to two-thirds, while commercial taxes have fallen to one-third. Bank loan officers have capitalized the tax cuts into larger mortgages, so housing prices have risen, not fallen. Los Angeles Mayor Antonio Villaraigosa exclaimed ruefully last year that “the time is now to address the inequity of Prop 13 that allows large corporate interests to get a windfall meant for homeowners. We are not funding government. We are just decimating government and the services it provides.”[1] He proposed a two-tier property tax, restoring higher rates for commercial and absentee investors.

School teaching is an exhausting occupation. That is one reason why teachers are one of America’s strongest labor unions. Their wages have not risen as fast as their expenses, because they have agreed to take less income in the short run in order to get pensions after their working days end. These contracts are now under attack – to pay bondholders. States and cities are now insisting that bondholders cannot be paid without stiffing their labor force.

So we are now seeing the folly of untaxing property and replacing tax revenues with borrowing – paying tax-exempt interest to the nation’s wealthiest bondholders. Cutting the property tax base thus finds its twin casualty in the wave of defaults on pension promises.

Real estate taxes have plunged from two-thirds of urban revenues in the 1920s to just one-sixth today for the United States as a whole. Federal grants-in-aid also are being cut back, and state aid to the cities is following suit. But instead of making housing more affordable, these tax cuts have “freed” rental value from the tax collector only to end up being paid to the banks.

Here too, California has led the way. In 1996 its voters approved Prop. 218, requiring any new tax, fee or property assessment to be approved by two-thirds of voters. (A few exemptions were made to keep local sew er and water systems viable.) This stratagem “starves the beast,” with the “beast” being public infrastructure and social services. Police forces are being downsized and social programs are cut back. And as urban poverty increases, crime rates are rising, imposing an “invisible” cost of living.

The most important economic fact to recognize is thus that whatever the tax collector relinquishes tends to be capitalized into mortgage loans. And by leaving more rent available to be paid as interest, cutting property taxes obliges homebuyers to go deeper into debt. Lower property taxes thus mean higher housing prices – on credit, because a home or other real estate is worth whatever a bank will lend to new buyers. So by capitalizing the after-tax rental value into a flow of interest, bankers end up with the rent – and hence, with the property tax cuts.

That is what a free market means today – income created by public-sector investment, “freed” to be paid to banks as interest rather than to be recaptured by government.

Most urban revenue is a free lunch created by taxpayer-financed roads, schools, sewers and water systems. But neither real estate speculators nor their bankers believe that this investment by taxpayers should be recovered by taxing the increased site values created by providing these public services. Instead of making the public sector self-financing as it expands public services to create wealth, private owners are to get the benefit – while banks capitalize the gains into larger mortgage loans, which now account for 80% of bank credit.

The core of the bankers’ “false consciousness” – the cover story with which Tea Party lobbyists are seeking to indoctrinate U.S. voters – is that taxes on land and financial assets punish the “job creators.” Going on the offence, the beneficiaries of this public spending claim that they need to be pampered with tax preferences to invest and employ labor, while the 99% need to be kicked and prodded to work harder by being paid low wages. This false narrative ignores the fact our greatest growth periods are those in which U.S. individual and corporate tax rates have been highest. The same is true in most countries. What is stifling economic growth is the debt overhead – owed to the 1% – and tax cuts on free lunch wealth.

The public pension squeeze is part of the overall debt crisis

Republican Vice Presidential nominee Paul Ryan and Texas Governor Rick Perry have characterized Social Security as a Ponzi scheme. This is true in the obvious sense that retirees are supposed to be paid out of contributions to new entrants. That is how any pay-as-you-go system is supposed to work. The problem is not that the system needed to be pre-funded to provide the government with revenue to cut taxes on the 1%. The problem is that new contributions are drying up as the economy buckles under its expanding debt overhead.

Social Security can easily be paid. After the 2007 crash the Fed printed $13 trillion on its computers to give to bankers. It can do the same for Social Security – and for federal grants-in-aid to America’s states and cities. It can pay state and local pension obligations in the same way it has paid Wall Street’s 1%. The problem is that the Fed is only willing do what central banks were founded to do – finance government deficits – to give to the banks. The aim is to save bondholders and the banks’ high-flying counterparties, not the 99%.

The problem is that the financial system itself is rotten. This has turned today’s class war into a financial war, with the major tactic being to shape how voters perceive the problem. The trick is to make them think that cutting taxes will lower their living costs and make housing cheaper, rather than enabling banks to take what the tax collector used to take. That is the key perception that needs to be spread: cutting taxes leaves more “free lunch” income available for banks to lend against, loading the economy deeper into debt.

Here’s why the present track can’t possibly work. State and local pension funds are $3 trillion behind because they are only making 1% returns these days (the only safe return), not the 8+% that they were told to make in order to pay pensions by “capital” gains (that is, the bank-financed free lunch). The Fed is keeping interest rates low in an attempt to re-inflate real estate and other asset prices back to the happy decade of Bubblemeister Greenspan. If interest rates rise – by enough to enable California, Chicago and other localities to obtain enough interest to pay retirees what they promised – then banks will see the collateral for their mortgage loans fall.

So the Fed has locked the economy into low returns. Neither Democratic nor Republican politicians are willing to raise taxes on the finance, insurance and real estate (FIRE) sector. They vote in line with what their campaign contributors are paying for – to make Wall Street rich.

At issue is the old Who/Whom choice. Given the mathematical fact that debts that can’t be paid, won’t be, the question is who should get priority: the 1% or the 99%?

Debt-ridden austerity and downsizing government is being urged as if it is inevitable, not a policy choice to put bondholders and the 1% over the 99% – a reward for the lobbying money it has spent on buying politicians and misleading voters to believe that cutting property taxes and cutting taxes on the rich will help the economy.

But if America still lets the 1% write the laws – or what turns out to be the same thing these days, to contribute to the political campaigns of lawmakers – then the economy will get much poorer, quickly. The era of America growth will be over.

Something has to give: If bondholders won’t be paid, states cannot pay labor’s deferred wages in the form of pensions, and will have to cut back public services.

So it’s time to default. Otherwise, Wall Street will turn us into Greece. That is the financial plan, to be sure. It is the strategy for today’s financial war against society at large. In Latvia, I spoke to the lead central banker, who explained that wages in the public sector had fallen by 30 percent, helping push down private-sector wages nearly as far. Neoliberals call this “internal devaluation,” and promise that it will make economies more competitive. The reality is that it will up the internal market and drive labor to leave.

Michael Hudson is the author most recently of The Bubble and Beyond (available on Amazon), which charts the financial and real estate pyramid at the root of the urban fiscal crisis. He is Distinguished Professor of Economics at the University of Missouri (Kansas City).

Notes.

[1] Adam Nagourney, “Tax Cuts From ’70s Confront Brown Again in California,” The New York Times, January 9, 2011.